BofA will outperform US stock market in ’18
Bank’s Q2 profit reinforce the trends, writes Matein Khalid
Bank of America, the second largest US money centre bank after J.P. Morgan, rose from 14 to almost 26 in the last twelve months, powered by a steeper US Treasury yield curve, record $17 billion profits in 2016, epic cost control, the Fed stress test capital returns windfall and the peak in its 2008 crisis related $70 billion litigation expenses. Bank of America is also the most interest rate sensitive among America’s Big Three banks, thanks to its trillion dollar retail deposit base in California and the fall in the ten-year US Treasury note yield from $2.40 to 2.24 per cent on disappointments over Trump’s legislative policy agenda, Janet Yellen’s dovish Congressional testimony and the decline in inflation expectations has led to profit taking in its shares, now trading at 24.
As the Federal Reserve shrinks (normalisation in Fedspeak) its $4.5 trillion balance sheet and the Trump White House rolls back Dodd Frank and even appoints ex-Goldman Sachs President as the next Fed chairman, I expect Bank of America shares to continue their bull run, even rising to $28 a share in the next twelve months. There is no real risk of a US recession, though Trump’s 3 per cent GDP growth promise is now a pipe dream. US housing is on a roll and mortgage put back losses will decline. The biggest threat to the bank is a U-turn in financial regulation or an unanticipated rise in credit risk. A stock market sell off could create an ideal entry point to buy the shares at 22 or 10 times forward earnings.
Bank of America’s second quarter 2017 earnings reinforce the trends that have boosted the bank’s operating leverage to the highest among its US money centre peers. Revenue growth was a stellar 23 billion, well above the $21.78 billion sell side analyst consensus estimate at a time when the bank has slashed $20 billion in operating expenses. Earnings per share were 46 cents, above the $0.43 EPS Street consensus. Investment banking fee income growth was 8.9 per cent though trading income declined, thanks to historic lows in volatility across asset classes.
The bank’s net interest income and net interest margins disappointed relative to expectations. The decline in net interest margins (NIM) offset the rise in earning assets and float benefits. The 5 basis point decline in net interest rate margins to 2.34 per cent was due to lower trading carry, ineffective hedges, the sale of the British credit card portfolio and sluggish North American consumer banking loan yields.
The silver lining in the bank’s results was the 45 per cent growth in merger and acquisition fees (true, Bank of America does not exactly dominate the global M&A league tables) but debt and equity capital markets underwriting revenue growth was mediocre.
It is now probable that Bank of America will deliver $1.80 EPS growth in 2017 and meet $2.15 EPS estimates in 2018. This means the bank now trades at 11.2 forward earnings, 1.3 times forward tangible book value and a 2 per cent dividend yield. These are relatively modest valuation metrics for a bank with a $2 trillion balance sheet, 17,000 wealth advisors (thanks to the shotgun marriage with Merrill Lynch’s thundering herds in the autumn of 2008) and a continuing fall in credit costs and non-performing loans. The bank’s fully loaded Basel Three common equity Tier One ratio is 11.5 per cent with a SLR ratio of 7 per cent.
Chairman/CEO Brian Moynihan has led Bank of America through its worst protracted crisis since it was founded a century ago by an Italian immigrant financier in San Francisco. His $18.5 million stock compensation for 2016 is tied to the attainment of a 0.8 per cent return on asset ROA) and a 8.5 per cent annual rise in tangible book value targets. This means the CEO’s interests are aligned with shareholders on a scale I rarely see in international banking. The easy money in Bank of America has been made but the banking colossus of Charlotte is still a must own for money despite the mixed second quarter.
Citicorp’s’ first investor day since 2008 confirmed my conviction that the most globalised US money center bank will also offer the highest EPS growth rate among its peers in the next three years. Even though Citi doubled its dividend, it still trades at a mere one times tangible book value and will return $20 billion in share buyback next year. No wonder Citi shares were such a winner since I recommended them as a must own at 45 last October.